Retailing records series; (part 3) Records become a commodity and face real estate prices and profit margins (III)

Like Sam Goody, Jack Eugster once sold tchotchkes, albeit as the head of a department store chain. Also like Goody, Russ Solomon started selling records as an ancillary to another business, in this case his father’s drugstore at the base of Sacramento’s venerable Tower Theater. Both, in their own ways, were Goody’s heirs.

Solomon took his success in the “record department” of his dad’s store and moved it to its own space in 1960. By 1968, he was opening the sort of store contemporary record buyers have come to associate with Tower Records: a freestanding (as opposed to mall) store. Located in San Francisco, it capitalised on the music of the Summer of Love, and became a favourite place for the denizens of the Haight to hang out. The store became a huge success, and Solomon started to expand. At the height of Tower Records’ success as a chain, Solomon owned (the company remained private until recently, and even now does not offer stock) and oversaw almost 180 stores on four continents, with over $1 billion dollars in gross annual sales.

Part of this success had to do with staying ahead of the curve of what customers want – but only slightly. Said Solomon:

Our company policy is to support new technologies, or, for that matter, to support anything the record companies come out with. It’s a natural thing for us to go along with the program, whatever it is. We don’t have an awful lot of risk, either, if you analyse it. If it doesn’t sell, we send it back.

As for Jack Eugster, when he took over the Musicland record chain in 1980, it was part of the American Can (Primerica by that time) retail music division that included Sam Goody. He led a leveraged buyout of the chain eight years later and by 1993 controlled 8 percent of U.S. music business sales, harking back to Goody’s similar achievement some 38 years earlier. However, Eugster played a considerably higher-stakes game. In 1955, Goody accounted for 7 percent of the market with about four million dollars in sales. In 1992, Eugster accounted for 8 percent with sales of about one billion dollars.

Fast forward a decade, and both Musicland and Tower are in deep trouble, along with almost all record retail. Not only have sales plummeted, but so have margins and foot traffic. The RIAA reported that between 1989 and 2004, the people who actually bought records did it… differently. Record-store sales had accounted for 71.7 percent of total record sales; that number fell to 32.5 percent. Those that went to “other stores” rose from 15.6 percent to 53.8 percent. (This was even before online stores like CDNow and Amazon dug out a significant niche; online sales as of 2004 still only accounted for 5.9 percent of total business.) The only thing that had not gone down at specialty retail record stores was the overhead.

Anyone who has been in a modern record store will tell you it takes up a lot of prime retail space. A freestanding store – the kind Solomon specialised in – might use 10,000–20,000 square feet or more. Even mall stores have had to grow to carry enough music to compete, especially if the mall has a discount department store that might use music as a loss leader.

At a time when this retail space can average $40 per square foot in a mall, can cost upward of $200 per square foot along a main shopping drag in New York to as low $35 per square foot in the city’s Garment District (not the fanciest neighbourhood); and range between $180 per square foot on the Strip in Las Vegas to an average of about $20 off the Strip; some thought has to be given to the profit margin of a CD, especially in the context of a store that sells little else.

Not that the contemporary record store concentrates solely on CDs. You might find DVDs, cases, blank CDs, players, books, magazines, and even memorabilia in many of these. They carry what the traffic demands. And it all takes up space they pay for by the square foot.

Now, let’s do a little math. At even the lower end of the rental spectrum, say $50 a square foot in New York, a 10,000-square-foot store costs half a million dollars a month in rental overhead alone.

Which brings us to margin. In 2003 Universal Music Group’s Jump Start program started a trend toward a lower CD wholesale price, but even so, a CD generally costs a retailer somewhere between $11 and $13 for a new-hit, major-artist release, and around $10 for “midline” CDs. The Jump Start program’s efforts proved to be too little, too late. When CDs first came out, they cost about 50 percent more than the vinyl albums they would ultimately replace. The record companies assured consumers that as the manufacturing prices came down, so would the prices of CDs. Only they never did. For years, the cognoscenti knew that it only cost about a buck to manufacture and package a CD, but the price of CDs continued to rise.

Since the retail competition is fierce, most stores cannot charge more than $15.98 for a new hit, or $12.98 for a midline CD. This gives the store a $2-$3 margin per CD, much less a percentage than Goody made when he devised the method of marketing music at retail. Divide an average margin of $2.50 into the $500,000 rent and the merchant has to sell 200,000 CDs a month just to pay the rent. This doesn’t include salaries, interest, or inventory, or even keeping the lights on. Clearly, this business model becomes more difficult to sustain every year.

Mike Dreese, CEO of New England specialty record chain Newbury Comics, offered more specific details:

On Fiona Apple, we are getting an 11 percent profit margin. On Nickelback, 10 points; Sevendust, 3.9 percent margin; Kanye West, 8 percent margin; and on Green Day, 9 percent margin. On the new Depeche Mode, we are sowing costs of $11.51 with a 6 percent margin… . The majors’ titles are coming out at crazy costs. You almost wonder what planet these guys are on.